Introduction
Today’s column wraps-up my rather extended assessment of the impact of the 2020 general crisis (as I have previously defined this phenomenon) on Guyana’s infant oil and gas sector. In the immediately preceding columns, I have been focusing on the emergent production cost structure, likely cost-price relation, Guyana’s global competitiveness, commercial and fiscal breakeven prices, as well as prospective Government Take (revenues) on offer, in our evolving upstream petroleum structure.
As regards the general crisis, its pandemic dimensions have stood out and have already so adversely impacted the global petroleum sector that it has placed Guyana’s lead Operator and Operations, ExxonMobil in the Stabroek Block, on the proverbial horns of an existential dilemma. As Greg Brewer writing in the Motley Fool has recently noted (November 20) that dilemma can be posed as: on the one hand, the risk of painfully low 2020 oil prices continuing deep into 2021. And, on the other hand, the unrelenting requirement for ExxonMobil to step-up its investments in order to grow production and maintain dividends.
As indicated earlier ExxonMobil’s main strategic response to the dilemma seems to be to 1) focus on high quality and low break-even production, as in Guyana; and, 2) transform and re-brand itself into an energy, not simply petroleum company. The latter is worth repeating for emphasis, as I use this opportunity here to remind readers that, Guyana similarly needs to strategize its future development primarily around energy in the broadest sense and not concentrate exclusively on petroleum. The reason for this is that, vast as its hydrocarbon potential is, its renewable energy resources, I believe challenges this potential for pride of place.
Starting in the next section, for the remainder of today’s column, I shall focus on rounding off my evaluation of prospective Guyana Government Take (revenues). In pursuing this, I’ll incidentally address a few specific concerns, which readers have raised privately.
More on prospective Government Take
To begin with, the overall revenue impact of Guyana’s Production Sharing Agreement (PSA) as captured in Government Take) has to be measured not only by the revenues it generates, but additionally by the extent to which the fiscal regime it enshrines simultaneously incentivizes and dis-incentivizes actions by the Government of Guyana (GoG), as Owner and the international oil companies (IOCs) as Contractor. These two contracting Parties to the PSA hold, as would be expected, differing goals and objectives.
And, despite the noise and nonsense of the social and print media, it is this conditioning circumstance that basic energy economics correctly asserts that, comparing PSAs by the presence or absence of particular fiscal levies, or indeed comparing fiscal levies by their size, is logically meaningless. I should add, unless the true aim is to mislead the uninformed. As a rule, every rational non-state economic agent is aware that the absence of taxes serves as profit incentive. Similarly, therefore, every rational government should be aware that it must always seek to reconcile this double-sided impact of all taxes.
As observed last week, no PSA is perfect. And, based on this condition, I believe five unique derivative considerations invariably apply These are: first, PSAs as designed seek to incentivize hydrocarbon exploration and development (E&D). In responding to this, IOCs are incentivized to pursue immediate profit and to defer riskier fields. This could have happened in Guyana in circumstances where it might indeed turn out that, the riskier fields, over the long run, will generate greater profit! This is a legitimate outcome. To the consternation of the noise and nonsense echo chamber, basic petroleum risk-reward theorems have revealed, invariably, that logic indicates, not criminal intent: the greater is the level of risk, the more is the expected immediate profit required to incentivize investors.
Second, because PSAs allow claims for specified accrued costs incurred in exploration & production (E&P), they tend to dis-incentivize efforts by the Contractor, which are aimed at cost reduction! The reason for this is that, in the PSA cost efficiency gains are shared with government, based on the pre-agreed profit-oil split! Regrettably, logic dictates again that, if IOCs are unable to benefit fully from their efforts to secure cost efficiencies, they may be dis-incentivized, when compared to situations that allow for full benefit.
Third, it goes without saying that, PSAs do create opportunities for IOCs to benefit from “windfall profits”. This can occur if after the contract is signed, global crude oil prices appreciate, for whatever reason, well above their historical trend.
Fourth, worldwide experience suggests that gold-plating cost is a widespread practice among IOCs. This is unquestionably a moral hazard. It serves to indicate a significant lack of good faith by the parties to PSAs. I believe this largely derives from information failure, which arises mostly from asymmetric information flows.
Finally, Government Take is treated as a cost by IOCs. As such, it certainly “defines a country’s competitiveness for internationally mobile E&D capital and it shapes global oil prices”. Data reveal that, globally, between 2009 and 2014 Government Take had averaged 52 percent. This is within the similar range as Guyana. As pointed out above Guyana’s global competitive advantage lies in two features; namely, the quality of its crude, light/medium sweet; and, its low break-even price. And, these are supported by the global transition to cleaner forms of energy as we noted recently in the maritime transport regulatory shift to low sulfur fuel.
Further, back in 2019, A, Bacci, Global Data’s Upstream Analyst in a response to the Department of Energy indicating its intent to raise Guyana’s PSA’s 2 percent royalty rate in its next licensing round due around now, had warned this could result in making it significantly less attractive, based on a typical global range of between 2 and 15 percent. Its modeling of Guyana at 2, 5, 10 and 15 percent supported this contention.
Conclusion
Next week I continue this discussion by introducing the IDB’s recent measurement of Guyana’s prospective Government Take